October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February. -Mark Twain
Dollar Cost Averaging (DCA) is a technique where, instead of investing a lump sum all at once, you spread it out over time. For example, maxing out a Roth IRA every year. Vanguard allows a good deal of freedom in setting up automatic deposits, so if I wanted to I could set it up such that the $5000 max is spread out over 52 weekly deposits. (I also have the choice of monthly, yearly, every 2 weeks, or twice a month.) In my case, $5000 divided into 26 equal payments works out to $192.31 every two weeks. By spreading out my investment over a large period of time, I’m Dollar Cost Averaging. There’s no specific time period that you have to divide your investment into, but the most common I’ve seen is anywhere from 1 week to 1 month. Regardless of the time period, the idea behind DCA is the same. By spreading out your investment over time you lower the risk of buying a lot of shares high or trying to time the market. It’s used as an automated strategy to buy more shares when the price is low and fewer when the price is high.
Sounds Good, But…
Does it work? Rather than creating a scenario like “Investor A invests a lump sum in fund XYZ in January while Investor B uses DCA to invest the same amount over a five month period” and then skewing the results so that DCA wins (see the Prudential example), I chose to uses real performance data for a few funds. I’m quite skeptical about contrived illustrations. Continue reading